The government has introduced a number of measures to curb the growth of buy-to-let landlords. But will they actually be successful? Stephen Little investigates
It has been a tough year for landlords who have been hit with a raft of changes designed to bring the housing market under control and help get more people on the property ladder.
A stamp duty increase for second homes has already been introduced and mortgage tax relief is set to be phased out from next year.
The Bank of England’s Financial Policy Committee is also expected to be granted more powers over the buy-to-let market in the coming months, which could make it even harder to get a mortgage.
To top it all off landlords have also been hit with new rules, from having to check the residency of their tenants to health and safety regulations.
The buy-to-let market has surged in recent years, with investors attracted by cheap mortgages, low interest rates and rising rents.
However, while the sector has historically been seen as a safe alternative to saving towards a traditional pension, that now looks about to change.
Many experts are predicting that the government’s new rules will drive landlords out of the rental sector and do little to solve the housing crisis.
In April, a 3% stamp duty increase was introduced as part of the government’s attempt to curb the buy-to-let market and free up property for first-time buyers.
Under the changes, the stamp duty on a £250,000 buy-to-let property rises from £2,500 to £10,000, while the rate for a £400,000 property more than doubles from £10,000 to £22,000.
John Heron, managing director of Paragon Mortgages, said: “I think the jury is out on whether stamp duty does anything positively for the buying capability of would-be homeowners. It clearly increases costs for landlords, but given that most landlords’ investment horizon is 20 years most look at the additional 3% cost and factor it in over the time they expect to rent a property. It’s less than welcome, but by and large they will live with it.”
In the run-up to the stamp duty hike there was a boom in borrowing as buyers brought forward transactions to beat the deadline.
The number of buy-to-let mortgage loans approved shot up a staggering 226% in the year to March, from 8,800 to 28,700, figures from the Council of Mortgage Lenders (CML) show.
However, residential property sales and mortgage approvals have plummeted since the hike. According to HM Revenue and Customs, house sales in April were 45% down on the previous month. Meanwhile, the CML said 4,200 buy-to-let mortgages were approved in April, down 85%.
Heron said: “Clearly there were short term impacts. Largely what we saw was landlords who already had transactions in the pipeline bringing them forward. You would expect business volumes to normalise over time but you have other factors in the environment at present, not least of which is the level of uncertainty surrounding the EU referendum.”
Mortgage tax relief
Chancellor George Osborne announced last summer that the government will limit mortgage interest relief for residential buy-to-let properties to the base income tax rate, which is 20%. This is due to be phased in over a four-year period starting from April 2017. Landlords are currently able to claim tax relief on the top rate of tax of up to 45%.
Many buy-to-let investors are now considering leaving the sector as they fear letting out a property will become far less profitable when the reforms come into force in April 2017.
According to the accountant Smith & Williamson, all returns for higher taxpayers will be wiped out if your mortgage interest is more than 75% of your rental income.
For additional rate taxpayers, the threshold is when mortgage interest is 68% of rental income.
David Cox, managing director of the Association of Residential Lettings Agents, said that the changes to mortgage tax relief could hit profits so badly many landlords could end up leaving the market.
He said: “We have to factor in that landlords in the private rented sector are not making huge returns on investment. Gross yields across the country are less than 5% on average, while net yields are around 2%.
“Landlords with low profit margins could end up making a loss as a result of tax change, which will push some out of the market. It will particularly hit highly leveraged landlords who purchased during the economic downtown when buy-to-let interest rates were at very low levels.
“We don’t agree with the government figures that this is likely to impact one in five landlords. We don’t know where the government has got those figures from. It is probably going to be half the market, if not more.”
Nationwide Building Society has calculated how hard landlords are likely to be hit by the changes. A landlord with a £150,000 buy-to-let mortgage on a property worth £200,000, charging £800 a month, would bring in a profit of around £2,160 a year. Under the new regime this would plummet to £960 a year.
Figures from mortgage broker John Charcol paint a similar bleak picture for landlords. According to the firm, a higher rate taxpayer who pays 40% tax with a rental income of £15,000 and a mortgage interest of £10,800 (66% of rental income) will see their profit fall from £2,520 in 2016/17 to £360 in 2020/21.
Heron said that landlords were feeling less confident about the market than they were previously.
He said: “Landlords won’t feel it in terms of the tax they are paying until 2018 and the full impact won’t hit them until 2021.
“The broad response we are getting from landlords at the moment is that those with one or two properties feel that they can cope with the changes and are unlikely to change their plans as a result. But we are finding landlords with larger portfolios are considering how they are going to structure their holdings going forward.”
Experts have warned that the increase in stamp duty and the cap on tax relief could cause landlords to raise rents in order to claw back the money lost or even lead to an increase in evictions.
Cox said landlords would likely try to recoup losses by increasing rents to tenants. He said: “Although the government has very laudable aims of increasing first-time buying, it is not going to have any impact for those trying to get on the property ladder because tenants are going to be paying the additional tax burden.”
New mortgage regulations proposed by the Bank of England’s Prudential Regulation Authority (PRA) could make things even tougher for landlords.
The Bank believes the buy-to-let market is a potential threat to the UK’s economic recovery and has suggested changes that include more stringent affordability and repayment checks.
The Prudential Regulation Authority wants lenders to take account of likely future interest rate increases over a minimum period of five years when assessing whether borrowers can afford to pay through stress tests.
This would require lenders to set a minimum rate of 5.5% during the first five years of a buy-to-let mortgage contract.
These changes to underwriting standards are expected to reduce the number of new approvals for buy-to-let mortgages by about 10% to 20%. There are also plans to toughen up checks for portfolio landlords who have more than four rental properties.
Heron said: “What they are asking is consistent with what experienced and established buy-to-let lenders have been doing for some time.
“The regulations will establish a level of discipline across the sector which means there will be a market wide minimum set of affordability requirements and that’s a good thing. That means we won’t see firms offering affordability measures which are unsustainable.”
The Council of Mortgage Lenders has urged the PRA to take into account a range of other regulatory changes already affecting the sector.
The Council of Mortgage Lenders said: “Lenders have been progressively tightening lending criteria in response to the stamp duty surcharge on landlords and changes in mortgage interest tax relief. The PRA’s proposals could reinforce these effects. We also reject the argument that further growth of buy-to-let can only be achieved by relaxing underwriting standards and increasing prudential risks.”
Case study: Will landlords feel the strain?
Angelos Sanders is one of the many thousands of landlords across the UK having to deal with the impact of the government changes to the buy-to-let sector.
He lives in the South West of England and currently owns nine properties which he rents out to families, students and local housing allowance tenants.
While he is unhappy about the introduction of stamp duty, he sees it as an additional cost that he will just have to bear.
He says: “As far as I am concerned it is the cost of doing business. I don’t want it, I don’t like it but I have don’t have a choice. It’s not necessarily going to be the end of the world.”
Angelos thinks mortgage tax relief will have a massive effect on landlords, forcing some to quit altogether.
He says: “Some landlords will have no choice but to drop out of the market and sell their properties as they will be loss making.
“Others will pass on the cost to their tenants through rent increases which will force some tenants to leave who can’t afford it. It’s going to affect tenants and all the trades that rely on landlords.”
He also thinks it is getting more difficult for new landlords looking to get into the buy-to-let market.
“Some lenders have tightened up their affordability criteria already, with more to follow. So first-time buyers will have to put in a larger deposit compared to experienced landlords.”
One option for landlords looking to boost their profits is to convert a home into shared accommodation. So-called house of multiple occupancy (HMO) are becoming increasingly popular with landlords tempted by larger yields.
While an HMO is potentially lucrative, Angelos warns that there are a number of possible pitfalls.
“You may have to apply for planning permission depending where you live. Plus there are lots of regulations and your lender might put you on a different mortgage when you convert.
“It’s also important to do your research and make sure the area that you are looking to invest in has the demand so you can fill your rooms.”
Landlords looking to get out of the buy-to-let market could be hit by further charges.
Those that want to sell their property will have to pay capital gains tax if they have made a profit, but not if they have made a loss.
Capital gains tax is charged at 18% for basic taxpayers or 28% for higher and additional rate taxpayers on the profit made from the sale of the property. However, as capital gains are added to income which determines the rate you fall under, this can push people into the higher tax bracket.
Heron said: “Landlords are clearly going to consider what is right for them. They will no doubt look at how the changes will impact their personal finances and change their borrowing strategies, while some may consider restricting new purchases and selling the stock they have got.”
Many landlords are setting up limited companies as they are still able to deduct mortgage interest from their rental income when calculating profits.
However, transferring an existing property to a limited company can incur a number of costs.
Landlords need to be aware that by doing this they face a stamp duty charge and also have to pay capital gains tax. There are also legal set-up fees and running a limited company will require landlords to file annual returns and accounts.
Ray Boulger, senior technical director at mortgage broker John Charcol, said: “Switching properties you already own to a limited company is going to be much more challenging as you are going to incur stamp duty and capital gains. But I think we will see a higher proportion of new investments done this way.”
According to Kent Reliance, around 38,000 loans were issued to limited companies in the first three months of this year, nearly four times the number issued in the same period in 2015. The number of loans to limited companies is expected to hit 100,000 by the end of the year.
Cox said: “I know there are companies and advisers out there that are saying to landlords ‘put your properties into a company it will make it all better and you won’t have to pay the increased mortgage interest relief’. But that is not always financially the best idea for some landlords.”
Despite the government crackdown, Boulger says there are still plenty of opportunities for buy-to-let investors.
“The fact that we are in a period of low interest rates that people can lock into means you can be pretty confident you are going to get a decent return.
“With the regulatory changes coming up I think that there is an added reason to go for a long-term deal.
“We are seeing rates come down. In the five-year fixed rate market there are mortgages at a 65% LTV and even 75% LTV at around a 3% interest rate.”
However, in response to the changing landscape some lenders have increased the amount of rent that landlords need to charge relative to their mortgage costs. This could make it more difficult to get a mortgage.
Already this year, Nationwide and Barclays have both tightened up their lending criteria for buy-to-let landlords by upping their rental ratio cover from 125% to 145% and 135% respectively.
The typical rental ratio cover in the industry has been 125%, and while there are still lenders offering buy-to-let mortgages at this rate, many experts expect this to change in the future.
The buy-to-let boom isn’t over,” said Cox. “There are changes coming, but as long as landlords are not too heavily leveraged they should be able to weather the storm.
“The market will stabilise. The property market has slowed quite dramatically in the last few months over uncertainty surrounding the referendum, but this always happens around election times.”